Peter Peterson’s Bad Economics

Advocates of cutting social security and Medicare in the US are using the financial crisis as a pretext to further their agenda

Wall Street investment banker Peter Peterson has been on a long quest to gut Social Security and Medicare, the core social insurance programs on which the country’s workers depend. He recently endowed a new foundation with a billion dollars to pursue this end.

Peterson and his crew are hoping that the financial crisis will help him accomplish his goal. His foundation has lately taken to arguing that because of the money spent bailing out the banks, we must make cut backs in Social Security, Medicare, and elsewhere. In reality this is just bad economics. The Peterson crew has either badly confused themselves or alternatively is deliberately trying to mislead the public to promote their agenda.

Before dealing with this issue, it is worth noting that Peterson has a long history of being wrong in a big way about major economic issues. For example, in the 90s he argued for partially privatizing Social Security as a way to increase benefits. If Congress had taken his advice, beneficiaries today would be receiving much lower benefits.

Peterson also argued that the consumer price index (CPI), the main measure of inflation, substantially overstates inflation. Based on this claim, Peterson wanted to reduce the size of the annual cost of living adjustment to Social Security. Peterson’s proposed cut would reduce benefits for older retirees by more than 20 percent. This is a major cut for the two-thirds of seniors who rely on Social Security for more than half of their income.

While Peterson used the claim that the CPI overstates inflation as a basis for cutting Social Security benefits, he never bothered to consider that this claim implies that incomes are rising much more rapidly than current data show. In other words, if Peterson had been right in his claim that the CPI overstated inflation, then our children (the supposed beneficiaries) would be far richer than we ever imagined possible because their incomes would be growing so rapidly. However, Peterson was so anxious to cut Social Security he never bothered thinking through the implication of his claim.

Now Peterson wants to use the bailout as a pretext for gutting Social Security and Medicare. There are two important ways in which the Peterson crew is trying to mislead the public on this issue.

First, the impact of the bailout on the debt is not as large as claimed. While the government is likely to lose money on these bailouts, it certainly will not lose everything invested. On the $700 bank bailout, it is unlikely to lose more than $200 billion to $300 billion. While this is not trivial, it is less than 2 percent of current GDP. The debt to GDP fluctuates by this amount all the time without even attracting any attention. It makes no sense to charge that we have to rethink our core social insurance programs because the debt to GDP ratio rose by 2 percentage points.

The other point on which the Peterson gang is misleading is the impact of deficit spending in an economic downturn. Such spending will not make our children poorer; in fact it is likely to make them wealthier by creating jobs and boosting the economy.

This point should be easy to see. If the government has a $300 billion stimulus (raising the debt by $300 billion), then the immediate effect on the economy will be to increase GDP by around $400 billion (assuming a well designed stimulus) and give jobs to approximately 4 million workers. The additional growth will lead to more tax revenues, so that the increase in the public debt will likely be closer to $240 billion rather than $300 billion.

But, even this is not a net loss to our children. While the country will owe $240 billion more than it would in the absence of stimulus, our children and grandchildren will also be the beneficiaries of the interest payments on this debt. (The fact that the money may be paid to foreigners who own the debt is immaterial, as I’ll explain in future writings on this topic.) In short, there is no good reason not to try to use the government as a source of demand for the economy during an economic slump like the one we currently face.

Unfortunately, Mr. Peterson either knows little economics or opts not to be honest with the public. In this respect it is noteworthy that he somehow managed to miss the housing bubble and the fact that its collapse would create the largest financial crisis since World War II. But, Peter Peterson is not interested in warning the country about the real crises it faces. He is interested in cutting Social Security and Medicare.